New Private Equity Opportunities Are Coming Thanks to the JOBS Act
Politics / US Politics May 05, 2012 - 06:34 PM GMTBy: Ron_Holland
An exceptional entrepreneurial company structure tainted unfairly by the actions of misnamed leveraged private equity buyout firms.
"Their new label became 'private equity,' a name that turns the facts upside-down: A purchase of a business by these firms almost invariably results in dramatic reductions in the equity portion of the acquiree's capital structure compared to that previously existing." – Warren Buffet
In the field of finance, private equity is simply an asset class made up of equity securities in operating companies that are not traded on a stock exchange. The term "private equity" actually implies the best in free-market and laissez-faire capitalism. For decades this term was used to describe private capital supporting any long-term, illiquid investment strategy whereby private investors started new companies using the private capital structure instead of a public corporation to fund the new venture.
But in our 21st century 1984 Orwellian world of Newspeak language of deception, manipulation of the present and the past and surveillance by a political and financial elite, definitions over time are changed. In this case, in order to entice new investors into questionable investments by mislabeling new products and investments with similar characteristics of older, more respected practices.
As Buffet stated correctly above, private equity firms like Romney's Bain Capital, hedge funds and divisions of major Wall Street firms actually use massive amounts of leveraged debt financing in order to take over existing firms, cut costs including employee jobs, send them overseas and then sell out, followed by the destruction of their existing stockholder base and equity from the debts forced on the company. This debt financing is actually the opposite of private equity but the promoters and media have sold this to the American public as "private equity" with "a name that turns the facts upside-down."
BusinessWeek recently described private equity as a rebranding and name change for what we used to call leveraged buyout firms back in the 1980s. If you see the term "private equity" used to describe mezzanine capital, leveraged buyouts, growth capital or venture capital know this is just rebranding and, in my opinion, a mislabeling of what is really going on.
But this false name identification trick is an old game. The bottom line: If it looks like a duck, swims like a duck and quacks like a duck, then it probably is a duck. Remember in Orwell's 1984, slogans like WAR IS PEACE, FREEDOM IS SLAVERY, and IGNORANCE IS STRENGTH were used to hide the truth of the situation.
The name and reputation of private equity has been ruined intentionally by the excesses of misnamed private equity companies using leverage to buy out existing firms for a quick turnaround and stock appreciation based on excessive debt leverage. Like the American Republic of today, democratic government and other popular structural descriptions that often mean and act exactly opposite of the original intent of the founders, the use of private equity has a proud, free-market entrepreneurial history. Private equity today offers a competitive solution to achieve fast growth, business success and profits almost unobtainable by many start-ups using a public company too soon in their development.
How Private Equity Compares To An Exchange Listed Public Company
"Zero Hedge first showed three weeks ago, the percentage of electronic trading in markets is now nearly 90%. But this, and everything else, is merely a symptom of one underlying cause: endless central planning intervention by central bankers who now have sole control over the stock market. Who in their right mind would want to participate? And yet this new normal 'vol to zero' regime is precisely what CNBC is cheering day in and day out." – Tyler Durden, zerohedge.com
The use of private equity today to finance start-ups rather than an initial public offering (IPO) offers investors the profit opportunities of private company investment with, of course, the reduced liquidity and additional risk inherent with new company start-ups. But investors also reduce additional risks inherent in public listed markets like short selling, market manipulation and dramatic current event risks that have nothing to do with a specific stock but can dramatically move market averages and underlying individual share values up and down.
In private equity, although liquidity can be quite limited, the political, current event and foreign policy risks are minimal compared to public exchange listed markets. Today in listed exchange markets rumors or immediate information flow can quickly impact national and global markets without regard to individual companies.
Likewise, flash trading, short selling and market manipulation and electronic trading by big Wall Street firms, hedge funds, central banks and government-allied interests are impossible with start-ups that remain private. Today electronic trading makes up almost 90% of all the trading volume, further alienating long term investors who know the playing field is not level for individual investors and advisors compared to the advantages for the computer trading firms.
The benefits of remaining private have been enhanced by the recent JOBS Act where the maximum number of investors has increased from only 500 accredited investors to 2000, including up to 500 unaccredited investors, and reduced reporting and auditing requirements with some public solicitation now permitted. However, all of this is conditional on final regulations to be issued soon.
The JOBS Act
As I discussed recently in "The JOBS Act: Washington Takes One Step Back Toward Capitalism," this tiny step back toward capitalism by Washington is decidedly not a gift toward prosperity and economic free-market ideals but rather a grudging crumb tossed to new start-up companies that create one out of every ten jobs in the United States. Second, and probably more important, this is an attempt by Wall Street and politicians to score in an election year with the powerful and very politically connected hedge fund community. The act will also allow them to advertise and promote their offshore and domestic hedge fund investment services more openly to American investors.
Private Equity Firms Are Far Different From Private Equity Financed Companies
The term "private equity" often deservedly carries a negative connotation for much of the investment public and even accredited investors who have heard the stories of private equity firms that use highly leveraged borrowed money to buy out and restructure companies. Movies like "Wall Street" and "Barbarians at the Gate" tell the story of these predatory, often politically connected private equity firms that borrow billions to take over and turn around a controlling interest in a public company, often using political and banking connections.
They fire employees, cut costs, dump pensions that are often taken over by the PBGC, funded by taxpayers, and then on the balance sheet return the business to temporary profitability. This happens at least long enough for them to hopefully sell their equity position and get out before short selling and dumping the stock creates another buying opportunity for another player in this seemingly endless merry-go-round between leveraged buyouts, hedge funds and other big Wall Street players.
There is often big money made by these politically connected corporate raiders. Their power is immense as these political/financial power elites move seamlessly between the shadowy worlds of Washington, think tanks and New York's Wall Street banking establishment. Many speculate that Treasury Secretary Timothy Geithner will land a cushy job in private equity after his questionable term as taxpayer bailout king for Wall Street ends in 2013. Hillary Clinton, like her daughter Chelsea, may end up there when her job as secretary of state ends.
These private equity firms, of course, heavily contribute to both political parties and this is where GOP presidential candidate Mitt Romney made much of his wealth. They and Wall Street control Congress and both majority parties because when these elites make the easy transition from Washington or regulatory agencies to "working in the private sector" this is where the political payoff comes for their years peddling influence in Washington.
The Opportunity For Entrepreneurship, Company Growth and Profits
"Overall, new businesses account for almost every new job created in America. For start-ups and small businesses, this bill is a game changer. Because of this bill, start-ups and small businesses will have access to a bigger pool of investors." – President Obama talking about the new JOBS Act.
This is true, but more importantly for the November election and the major financial support provided by the hedge fund industry, the act effectively curtails many years of restrictions and will allow hedge fund managers to promote their businesses more publicly with their performance and investment strategies by speaking, writing and advertising.
The 12 Benefits of Private Equity Start-ups to Publicly Traded Companies
A Source of Long-Term Capital Investment – Individual investors in private equity can provide an important source of capital that is long-term, historically illiquid and committed to the success of the business.
Investors Have A Personal Stake In Company Success – The limited number of shareholders, formerly 500 but now up to 2,000 investors, often consider themselves real stakeholders in the company because their profit and stock appreciation or loss is dependent to a great degree on the profits and growth of the private company.
No Short-Selling Possible to Drive Down Share Price – We have all seen the excesses of short selling in recent years and, of course, this is not a concern for private equity financed companies.
No Stock Price Manipulation – Again, stock price manipulation by Wall Street firms, questionable research reports or general exchange dramatic price movements from current events or central bank actions are not a concern with private equity. Private equity also avoids the increased risk of extreme price and price volatility from day trading activities.
Reduced Need For Debt Financing – Private equity investors are usually superior to debt financing by a bank or outside lender as they are entitled to interest plus repayment of the principal on the loans outstanding. If you are a start-up or new business venture excessive debt means the bank owns you. On the other hand, giant conglomerates, global industries and quasi monopolies that use excessive debt often own and control the bank for obvious reasons.
Reduced Transparency, Reporting Requirements and Regulations – One systemic competitive disadvantage American public companies have over many foreign competitors is the requirement to manage quarter to quarter instead of taking the superior long term view of growth, profits and dealing with competitors. This disadvantage is enhanced when your competition knows almost as much about your financial condition as the management of a public company due to reporting requirements. There is far less transparency for private equity companies.
Lower Regulatory Costs & Bureaucratic Delays Than Public Firms – Private equity companies can offer a cost and time savings with government bureaucracy compared to public companies. This allows management to spend more productive time and effort running the company to achieve growth and profit projections and less wasteful effort in completing quarterly reports to the SEC and other bureaucracies.
A Limited Number of Shareholders and Management Working Together – One important key to business success is where the limited number of shareholders and management are working together to meet the same objectives. Private equity-backed companies often have a synergy between management, directors and shareholders where even shareholders can communicate with management offering suggestions, center of influence and valuable advice in favor of or in creative opposition to business plans and activities. This important advantage of open communications really can benefit a private company over a public listed company type of structure.
Faster Growth Rates Than Public Companies – Many studies show that most private companies have higher growth rates than comparable public companies in the same line of business. This is because of the advantages mentioned earlier in the list.
Private Companies Better Control Timing of Sale or Going Public – The management and directors of a private equity company along with stockholders control the best method and timing of selling out or going public with an IPO in order to get the best possible share price for the company assets.
In a Private Company Most of Management are Also Investors – For this reason they are highly motivated to work toward the same goals as shareholders: profits and increased share values. Studies show this is the best environment for both shareholders and management. These shared goals historically do better with a private equity company, although investors must take into account the increased risk of start-up companies as well as buyouts and takeover candidates.
The Most Effective Form of Ownership and Management in Today's Business Environment – As we have discussed in detail above, a private equity company is a superior form of ownership when quick changes in leadership and direction are required in our fast-paced, global economic environment. Often in very competitive environments, these changes need to be made quickly and privately, away from competitors, which is an additional advantage of private equity.
How You Can Benefit – I'm CEO of Biologix Hair Inc. and as a private equity financed start-up, we see real benefits to the changes created by the JOBS Act. Because of our present private equity structure, rather than a publicly traded company, regulatory changes created by the JOBS Act will allow us to be better able to communicate our story and vision to potential accredited investors interested in our global opportunity for hair restoration. The increase in individual shareholders from 500 to 2000 will also give us a better chance to delay and decide when and if we should go public at some time in the future.
Watch for More Private Equity Situations and Opportunities – The rise of electronic trading up to 90% of the daily exchange traded volume, the crashing of viewership for CNBC, the flash crash, short selling, hedge fund actions and rampant manipulation of major markets as well as individual stocks is causing many investors to look elsewhere in these troubling financial times. I believe interest in gold, private equity and other alternatives to standard Wall Street fare will continue to grow.
The JOBS Act will likely create a surge of new companies using private equity for financing to access the benefits previously mentioned. This is reason to search for other unique private equity start-ups like Biologix Hair Inc.
Of course, the usual cast of characters and firms on Wall Street will jump on this new business bandwagon but I suggest readers also consider more free-market and entrepreneurial candidates and opportunities incorporated in the US but marketing and competing with the tax and free-market advantages available globally in markets outside the United States.
Just remember that liquidity is far less accessible with private equity and new business start-ups by their very nature have more risk than widely traded shares on an exchange. Nonetheless, accredited investors and others who can handle more risk should certainly avail themselves of the diversification benefits and potential profits of private equity, especially now with the reduced negative regulatory impact enabled by the JOBS Act.
Ron Holland [send him mail], a retirement consultant, works in Zurich and is a co-editor of the Swiss Mountain Vision Newsletter. He is the author of the special report, "Get Ready To Escape the Obama Retirement Trap" and you can email him for the complete report.
© 2012 Copyright Ron Holland - All Rights Reserved
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